According to an article published in the Los Angeles Times, a Short Sale can hit your credit rating up to 130 points according to researchers at VantageScore. While this is a big hit there are several advantages to a Short Sale over letting your home foreclose. Typically owners that sell their home short have missed several months of mortgage payments and that is usually what affects your credit. The actual formulas for calculating credit scores are kept secret but typically you can get a new home loan in less than three years after a short sale.

If the bank forecloses on your home your credit rating can take a hit of up to 150 points and the record of foreclosure can stay on your credit report for seven years.

For those that choose Bankruptcy look for a credit drop of well over 300 points and ten years on your credit report.

Buying a foreclosure is for the pros with a big checkbook. In Marin a “real” foreclosure is literally sold on the steps of the courthouse on Fifth Avenue in San Rafael. The buyers have several denominations of Cashers Checks that add up to the maximum they will pay. They bid against each other and the bank that holds the loan on the house and is foreclosing on it. The bank has the upper hand because they don’t have to write a check unless the bidding goes over the loan amount.

You will be bidding on a house you likely have not seen on the inside. No bank will lend you money until you buy the home. This is a cash transaction that does not come with title insurance.

When you hear someone say they bought a foreclosure that usually means they purchased a home that has already been foreclosed on by the lender. They are known as REO’s, which stands for Real Estate Owned (by the bank). When buying an REO the paperwork sucks. Banks expect buyers to start their inspection and financing timelines without so much as a signed offer acceptance from the bank. In many cases the acceptance of the offer is conveyed to the buyer verbally. As you know, in real estate verbal does not cut it, the law requires everything in writing. But as long as you are getting a good deal are you really going to fight with the bank that selling the house?

Homes are also sold in pre-foreclosure status which may mean the seller had a notice of default (they are late in mortgage payments) or it is a short sale. In a short sale the seller gets the bank to agree to sell the home for less than the amount owed.

Short Sales are relativity new to the real estate/banking world. What is a short sale and how do they affect buyer’s, seller’s, and banks. Simply put a short sale is where a home sells for less money than the seller owes the bank and/or private lender.

For example, if you owe $500,000 on a house but it sells for $350,000 you are short $150,000 of the amount needed to pay off your loans. Usually, because of commission, taxes, late payments, and expense the “short” amount might add up to another eight or ten percent, in this example the seller might be short $190,000. What happens now, doesn’t the bank still want all their money? Of course they want all their money but what are they to do if the seller does not have any money and the house value has declined? What they do is eat the difference, the short amount.

The bank will usually forgive the borrower the short amount and write it off as a loss. They made a bad business decision and have to pay for it. Usually they lent the buyer %100 of the money needed to purchase the home, and often without supporting documentation on the buyer’s income or assists. It is called loose underwriting and those days are over. It really was a dumb idea; when you think about it, even if the value of the home remained stable the bank would have expenses if they took back the home to sell. In a declining market it just makes it that much worse. Is this predatory lending, yes in many examples it is. Did the buyer’s lie on their loan application? Sometimes they did but other times the mortgage broker filled in the numbers. Did the buyer’s know their interest rate was going to jump in a few years? Many did but maybe he was not given all the information up front.

Okay, so we learned the bank eats the lost money but what happens to the buyer? In the vast majority of cases the buyer does not owe the bank any of the shortfall, however, in most cases the buyer has a bad credit score as a result of the short sale. Better than a foreclosure but bad none the less.

Prior to a new law moving its way through the system (I think it is finally in effect – consult with your accountant for details) buyer’s that shorted a bank on a sale would owe tax to the IRS and state on the amount of money forgiven. In the example above the buyer would have owed income tax on an additional $190,000 of income.

If you are up-side-down on your home (owe more than it is worth) and are considering foreclosure or a short sale you need to know the ramification each option has.

If you purchased your California home in the past couple of years with 100% financing and the home is worth less than your purchase price foreclosure may be your best option. This may also only be true if you have NOT refinanced your home. You see, in California, in a foreclosure the bank has no recourse on your assets beyond your home (original purchase money only- does not apply to refinanced property). So if you want to walk from the house -give it back to the bank, the hit you take is on your credit rating for seven years.

Option 2 might be to sell your property and ask the bank to forgive the difference between your loan and sells price. Even if the bank will not forgive you the difference this is called a short sale. In a short sale your credit is not hit as bad as a foreclosure. However, the bank will likely come after your other assets AND (this is a big one) the IRS will tax you on any amount forgiven by your lender. Don’t forget when the IRS wants your money they get it.

If you want to refinance your property to keep the payments low that will be hard to do at 100% financing and it may take away the best foreclosure on original purchase money has to offer.

Because this subject has such legal and financial ramifications if this article applies to your situation get professional legal (attorney) and financial (CPA) advice.Warren Carreirowarren@RealtyOfMarin.comwww.realtyofmarin.com